The Relationship between Capital Structure & Profitability of Public Sector Banks in India

This study seeks to provide evidence on the impact of capital structure on the performance of Indian public sector banks as measured from their Return on Equity (ROE). The analysis has been done on a sample of 19 public sector banks from 2008 to 2012. The findings of study validated a positive relationship between short term debt to capital (STDTC) and profitability as measured by ROE. Long term debt to capital (LTDTC) Total debt to capital (TDC) and Total assets(LTA) are found to have a negative relationship with Return on Equity (ROE). Results also indicated that there exists a positive relationship between Size (log of total assets) and profitability (i.e. ROE) of Indian public sector banks. This supports the theory that debts are relatively cheaper than equity and hence increase the Return on Equity Booth et al. (2001).

The results support part of earlier findings by Fama and French (1998), Graham (2000). The evidence also lends support to the Trade-off theory. Evidence of a size effect is present and this indicates that the larger firms in the sample tended to employ more debt in their capital structures. The study may be useful to the banks for designing their capital structure to improve their profitability and market capitalization.